Property taxes are payments you make to help fund your local, city and state governments so that they can provide you with public services.
And that’s important. Ask yourself where you would be without vital community services like fire, police, schools, sanitation and, of course, local parks and recreation facilities.
You may be wondering how your property taxes are collected, especially if this is your first time owning a home. They don’t come out of your paycheck and you don’t pay them through the IRS.
Instead, your property taxes are usually included in your monthly mortgage payment, though you can pay them directly. Either way, the money goes directly to your state, county and local governments to help fund your community.
So how does this work? Why are you paying taxes with your mortgage? How much do they cost and how are they collected? Never fear! We’ve got the information you need to figure it all out.
How Do Property Taxes Work?
Once you buy a home, you’re required to pay property taxes. In fact, you may need to pay some at closing. Your first regular payment toward your property taxes will be included in your mortgage statement.
Property taxes work differently for every type of community, and it’s important to know how much you’ll be charged before you become a homeowner.
Why? Because property taxes can affect the total cost of homeownership, but may also be a vital measure of the quality of services (schools, police, etc.) offered by the community where you’re looking to live.
Difference between real estate tax and property taxes
Long story short, real estate taxes and property taxes are different names for the same thing. Both terms get used because the IRS refers to property taxes as real estate taxes, but essentially it’s all property taxes. It’s money you pay to your state, county and local government to pay for public services.
One additional type of property tax you may see is a special assessment tax. These are additional property taxes a community may levy (ask people to pay) to cover costs for a special project like a new infrastructure project (think: a new road or school building).
Communities are required to announce any special assessment plan to the public, usually through a town or city council where the public can weigh in on the issue. Once the assessment passes, the tax will become part of your property tax bill.
At closing, the buyer and seller pay for any outstanding property taxes for the year, usually based on the time lived in the home since the last payment was made.
How Do I Pay Property Taxes?
As a homeowner, you usually have two options for paying your property taxes. You can pay them yourself through a direct payment, or you can put money into escrow each month to put toward your property taxes. Let’s take a closer look at each method.
With a direct payment, your local government sends you a bill for your property taxes annually, semiannually or quarterly. When you receive the bill, it’s up to you to pay on time and in full. Otherwise, you risk getting a tax lien placed on your property.
While direct payments give you a greater level of control over your money, most homeowners tend to pay money into an escrow account each month.
With an escrow account, your mortgage lender or servicer collects your mortgage payments to cover your principal and interest. They also collect an additional amount each month that goes into your escrow account to cover expenses like property taxes, homeowners insurance and homeowner association fees.
Your escrow account is usually set up when you first get your mortgage and the amount you pay each month needs to be specified on your monthly statement.
The fact is, most homeowners use a mortgage escrow account to cover their property taxes for these reasons:
- It’s convenient: Because tax payments are usually paid annually or semi-annually, setting money aside each month means you build a big payment gradually, and you don’t have to worry about getting caught without the funds you need when the property tax bill comes due.
- Your lender knows taxes: Your lender or mortgage servicer may be better equipped to estimate how much you’ll need if property taxes go up or down and can adjust your escrow payment accordingly.
- It’s required: Many lenders require an escrow account for government-backed mortgages like Federal Housing Administration (FHA) loans and Department of Veterans Affairs (VA) loans. Lenders may also require an escrow account for a high-priced or jumbo loan and for conventional mortgages if you pay less than 20% down.
The good news is that all of your property taxes are usually folded into a “superbill” at the county or town level, so you don’t have to submit individual tax payments to your state and local governments.
Even if it isn’t required, paying property taxes through an escrow account with your mortgage is usually more convenient and your lender may offer you a better interest rate. Why? Because using an escrow account means your lender will feel more secure knowing that you won’t forget to pay your property taxes.
Want to check your lender’s math? You’ll still get a tax bill showing how much you owe, so take time to review their calculations for errors.
How Do I Calculate My Property Taxes?
How much will you need to pay in property taxes? It depends on where you want to live. The basic formula to determine how much you need to pay in property taxes is this:
Assessed value x property tax rate = property tax
Seems simple, but let’s look at the two key elements.
The assessed value of your home (for property tax purposes) is not always the same as the fair market value of your home (the amount of money you can sell it for). Not sure what that all means?
Well, each county has its property tax assessor who determines the value of your home based on a variety of factors including:
- The value of comparable properties in your area
- Depreciation based on the age of your home
- How much income you could make if you rented out your property
Based on local criteria, it’s likely that you’d only pay taxes on a percentage of your home’s fair market value. Some communities even offer property tax exemptions, which means you could pay a smaller percentage of the value of your home in property taxes at the local level.
Property tax rate
Different states and communities charge different property tax rates. You could live in two different adjacent communities in the same state and pay radically different taxes rates.
The property tax rate that you pay at the local, county and state level is often referred to as the millage rate or mill rate. These rates are usually based on how much you’re required to pay per $1,000 of home value. So if your state has a mill rate of 0.8% (multiply by .008), that’s $8 for every $1,000 of home value.
Crunching the numbers
So let’s say you live in an area with:
- State mill rate: 0.8%
- County mill rate: 0.6%
- Local mill rate: 0.7%
That means your total millage is 2.1% or $21 per $1,000 of home value.
If the assessed value of your home is $200,000 your annual tax bill would be $21 times 200 or $4,200 or $350 per month.
What Happens When I Pay Off My Mortgage?
Unfortunately, you still need to pay property taxes, even after you own your home. Once you’ve paid off your mortgage, your lender can’t maintain the escrow account either. So, you’ll need to pay your property taxes directly and remember to save enough throughout the year to cover them.
You can also set up a personal escrow account with your local bank or a private escrow lender. From there you’ll continue to make monthly payments to this new escrow account to cover your property taxes.
What Happens If I Don’t Pay My Property Taxes?
Local and state authorities count on property tax revenue to provide services. So, they take strong measures when people fail to pay their property taxes. If you don’t pay, they may place a lien on your property.
A lien is a legal claim that lets them take possession of your property and sell it to cover the debt. If there are liens on your property you won’t be able to sell or refinance until they’re paid off. Every state has a different redemption period (think: time to pay off a lien) so it’s important to know your local and state laws on this process.
In some areas, if they don’t place a lien on your property, they can sell the debt (let someone else buy the debt from them at a discount) to private tax collectors who are known to be very insistent about getting their money. Either avenue means very uncomfortable times for anyone who defaults on paying property taxes.
Adding Property Tax to Your Mortgage Could Save You Time
Understanding your property taxes is an important part of becoming a homeowner. Property taxes can also be complicated and change from year to year. That’s why it’s a good idea to include them with your monthly mortgage payment. It’s automatic and one less payment you might overlook.